the great depression

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  • 1. The Great Depression1929-1933 The Defining Moment

2. Why Great Depression Ben Bernanke: To understand the Great Depression is the Holy Grail of macroeconomics. Not only did the Depression give birth to macroeconomics as a distinct field of study, but also---to an extent that is not always fully appreciatedthe experience of the 1930s continues to influence macroeconomists; beliefs, policy recommendations and research agendas..We do not yet have our hands on the Grail by any means..(JMCB, 1995) 3. Rex Tugwell(advisor to Roosevelt)The Cat is out of the Bag.There is no invisible hand. There never was. If the depression has not taught us that we are incapable ofeducation..We must now supply a real and visibleguiding hand to do the taskwhich that mythical, nonexistent, invisible agencywas supposed to perform,but never did. 4. The Prelude 1919-1929 U.S. enters the war late. (1917-1918) effects on U.S. economy relatively small compared to European economies. Huge damage and disruption to European economies. Real GDP = 100 in 1913. In 1919, UK=101 France=75 Germany=72 US = 116 Inflation! Price level = 100 in 1914. In 1918 UK=210 France=213 Germany304 US=164 Huge climb in Debt/GDP ratios. 5. Consequences 1. World War I---9.5 million deaths. Loss of ageneration (UK 1m, France 1.4m, Germany 2m,US 114,000) 2. Destruction of physical capital especiallyBelgium and northern France 3. Distortion of patterns of production, trade andconsumption (e.g. high wartime prices forcommoditiesboom and collapse in U.S. 4. High cost of war. Estimated $208 billion. 5. Political and economic borders of Europe areredrawn. 6. Inter-allied war debts and German reparations. 6. Inter-Allied War Debts ($ billions)(Kindleberger,The World in Depression France 4.0 3.0 4.7 3.5 United States United Kingdom 8.13.2 Other CountriesTo pay principal and interest, war devastated economies would have to run balance of payments surpluses. 7. German Reparations John Maynard Keynes (1919) Reparations were a policy of reducing Germany to servitude for a generation, of degrading the lives of millions of human beings, and of depriving a whole nation of happiness. They were abhorrent and detestable. tienne Mantoux (1946) Reparations not excessive, destructive or uncollectible. The French paid in 1815 and 1871---Le Boche Paiera 8. The magnitude of reparationsIndemnity Percent Share of (billions) of OneDebtYear's Service GDP to GDP France 1815-1819 FF 1.65 to 18 to 21 1.2 to 1.41.95 France 1871FF 5.0250.7 Germany1923-1931 DM 50 832.5 Vichy 1940-44FF 479 1112.6 Germany1953-1965 527 US$7.70.4 Japan 1955-19651486 US$ 3.00.8 9. Solution---the Dawes Loan 1924 German Hyperinflation. Dawes Loan---begins series of loans--- U.S. provides funds and funds for investment around the globe. New York as central of global financenot London 10. Return to Gold Standard Status Quo Antebellum No problem for U.S.huge balance of payments surpluses and gold U.K. deflates and returns to gold in 1925 at old parity 1 = $4.86. But overvalued. Depressed economy. France with near hyperinflation returns to gold in 1926 at a new parity (old $1= 5FF now $1 = 25.5 FF) Undervalued currency. Booming economy. Germanys hyperinflation---returns to gold at near purchasing power 1925. Major imbalances---brittle equilibrium. 11. Adjustment under restored gold standard more difficult International capital markets are revived--- generally free. International labor flows almost eliminated immigration restrictions Increased protectionism Less wage flexibility. Wage now seem sticky even with high unemployment 12. U.S. Economic Prosperity in 1920s No trend inflation High productivity growth 1922-1929, GNP grew at 4.7%, Unemployment averaged 3.7%. Fed accommodated seasonal demands for credit and attempted to smooth economic fluctuations. (2 brief recessions) 13. Some basic numbers Peak August 1929, Trough May 1933 Real GDP falls 39% Real Consumption falls 29% Prices (GDP deflator) falls 23% Unemployment Jumps: 3.2% in 1929 25% in 1933 (21%Darby) 17% in 1939 (17% Darby) Banking Collapse July 1929, 24,504 banks, $49 billion deposits. December 1932, 17,802 banks, with $36 billion. After Bank Holiday March 1933, 11,878 banks with $23 billion deposits. 14. Key American Role in World Depression Based on industrial production GD starts in most countries at the same time But it is larger and longer in the U.S. Romer (1993) 15. Worst in the U.S. For the U.S.,IndustrialProduction Biggest drop infirst year Biggest droppeak to trough Biggest drop inthe last year. However, turningpoints are verysimilar 16. Understanding the Great Depression: Its Evolution by PhasesReal GDP, 1920-19411. Booming Strong Economy in 1920s 1402. Beginning Shocks, 1928-1929 3. Aggravating Shocks, 1930-1933 1304. Rock Bottom and Recovery, 1933-1936 120 5. The 1937-1938 Recession 110 6. The Recovery, 1939-19411929=100 10090807060 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 17. Understanding theGreat Depression: Four Basic Questions Real GDP, 1920-19411401. Why it Began? 2. Why so Deep? 130 3. Duration?1204. Recovery?1101929=100 100 90 80 70 60 1920 1921 1922 1923 1924 1925 1926 1927 1928 1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 18. Understanding the Great Depression:Its Evolution by Phases 1. Booming Strong Economy in 1920sbuta) Its the Roaring Twenties!b) No trend inflationc) High productivity growthd) 1922-1929, GNP grew at 4.7%,e) Unemployment averaged 3.7%.f) Fed accommodated seasonal demands for credit andattempted to smooth economic fluctuations. (2 briefrecessions)g) BUT: Weak American Agriculture: low prices, high debt,weak banksh) BUT: Weak Europe: reparations, debts to U.S., slowgrowth, gold standard fragile (overvalued , UK slumps)and (undervalued FF, France booms)i) BUT: U.S. Stock market boom halts foreign loans toGermany, Eastern Europe and Latin America 19. Understanding the Great Depression:Its Evolution by Phases 1. Beginning Shocks, 1928-1929 Spring 1927 U.S. expansionary monetary policy to ease pressureon the British balance of payments. Critics assert policy too easy,and allows stock market boom to ignite Fed tightens policy in 1928 (discount rate 3 to 5%, and there islittle increase in total money or credit for 1928-1929. U.S. stock market boom begins March 1928. Commercial paper market vanishes No new lending to Germany, Austria and rest of work in1928.Germany slides into a recession. Fed tries to jaw-bone market down. Criticizes brokers loans. July 1929 raises discount rate from 5 to 6%. But July-August is peak of business cycle. Recession beginsSummer 1929 October 1929 U.S. Stock market crash: wealth effectlowersconsumption and investment, credit effectreduces value ofcollateral and hence lending Smoot-Hawley tariff 1929 by U.S. induces retaliatory tariffs byother countries, international trade declines 20. Understanding the Great Depression:Its Evolution by Phases 1. Aggravating Shocks, 1930-1933a) Banking Panics, 1930, 1931, 1933Failure of the Fed to Pursue Expansionary PolicyCollapse of Gold Standard: Austria, Germany leave the gold standard, Britain departs after a run on the pound in September 1931U.S. begins losing gold, trade deficits and capital flight. 2. From Rock Bottom to Recovery, 1933-1936Bank Holiday March 1933U.S. abandons the Gold Standard March 1933New Deal Banking and Securities LegislationMonetary ExpansionMinimal Fiscal Policy National Industrial Recovery Act (NIRA) 3. The 1937-1938 Recessiona)The Fed Raises Reserve Requirements 4.The Recovery, 1939-1941a) Monetary Expansionb) Fiscal Expansion in preparation for war. 21. Four Basic Questions: 1. Why It Began?2. Why So Deep and 3. So Long? Friedman and Schwartz (and others), the economy is entering a recession in late 1929 The economy is beginning to recover in 1931 like a normal business cycle BUT what makes the recession worse? What turns the recession into a depression? 22. The Worsening Depression Slight recovery early 1931,then plunge. Why? Romer (1993) The source of the continued decline in production in the United States was almost surely a series of banking panics. Friedman and Schwartz (1963) document four panics Fall of 1930 Spring 1931 Fall 1931---Britain abandons the Gold Standard First Quarter 1933 9000 Banks suspend operations. Depositors and stockholders lose $2.5 billion = 2.4% of GDP...not the whole story 23. Why are there banking panics? 24. Why Banking Panics? There were no banking panics in Canada. Fragmented unit banking system Undiversified bank portfolios with high regional concentration of loans. Large number of bank closures in the agricultural states when agricultural prices fall. In addition, many hold bonds whose value collapsed. Many banks become insolvent Fear of insolvency feeds the liquidity crisespanics. 25. Effects of Banking Panics Money Supply Declines and there is a massive rise in realized real interest rates, over 10%. Friedman and Schwartz blame inaction of the Fed for this decline---and hence for the depression. 26. How do Friedman and Schwartz explain why the Fed did not act? Up to end of 1930 What is the Fed concerned about? How does it react to banking failures? Who was Benjamin Strong? New York Fed v. Board of Governors? What could the Fed have done 1930-1931? What does Congress do? 27. Why didnt the Fed act? Beginning in 1931, Friedman and Schwartz argue that Fed could have expanded but chose not to. In diary of Charles S. Hamlin member of the FR Board, he wrote during August 1931 that Open market committee voted 11 to 1 against $300 million open market purchase of bonds---reduce it to $120 million. Governor Mayer of the Board worried about inflation. Members of the regional banks did not grasp the extent of the crisis. Pressure from Congress---open market operations of $1 billi